Banking institutions provide financial assistance to public water systems to design and construct capital improvements to drinking water system infrastructure. This section provides an overview of the financing tools available and an explanation of the process.
Banks lend money to public water systems and like other funding partners evidence that loan with one of two instruments:
- municipal bond certificates; or,
- lease purchase agreements.
The bank’s benefit for lending the money is received from the interest charged on the loan. Interest paid by publicly owned water systems is exempt from federal income tax requirements, allowing banks to charge a lower interest rate than would otherwise be charged.
Because banks lend money to make money, interest rates are determined by market conditions present at the time the financing takes place. Interest rates are a function of a bank’s cost of funds, the credit profile of the borrower, and the credit structure of the financing instrument used. To determine the best course of action, the public entity will generally contact their public finance banker. Although the process varies by institution, in general obtaining bank financing is fairly simple and involves the following steps.
- Provide financial information regarding the governmental entity.
- Provide details regarding the project.
- Determine the timing of the project and when funds are needed.
- Determine the financing tool that works best.
- Finalize credit and pricing determination.
- Execute the necessary steps to consummate the transaction and close the loan.
A decision to provide bank financing can be obtained within a week or two in most cases. Executing the necessary steps to finalize a transaction depends on which instrument is used, but ranges from one to three months in most cases and can take much longer in some cases. These cases are rare.
Governmental entities in Utah are political subdivisions of the State of Utah, with laws dictating the process by which funding occurs. If these laws are not followed, the financing would be considered illegal, and therefore not enforceable for repayment.
The key legal steps required to sell municipal bonds generally follow the pattern below and can be taken simultaneously with the financing steps outlined above.
- Initial resolution of the governing body starting the process.
- Public hearing.
- Authorizing resolution of the governing body.
- Closing and funding.
It is possible to combine the resolutions approved by the governing body to expedite the process.
- Types of Municipal Bonds
Municipal bond is a generic label describing a wide variety of tax exempt obligations. Governmental entities may issue different types of municipal bonds depending on the revenue sources that they receive and that can legally be pledged. The decision regarding the correct type of municipal bonds to sell can usually be determined by examining what will be pledged, the nature of the project, and the expected source of repayment.
G.O. bonds pledge the ad valorem property taxes of a governmental entity and usually use this property tax revenue stream to repay the bonds. These bonds can be used to finance water system projects or energy conservation projects and are typically viewed as being low risk and, therefore, result in lower interest rates. These bonds must be approved by over 50% of the voters in a special bond election held in November. There is a limit to the amount of G.O. bonds that can be issued based upon market value, population, and the type of governmental entity.
Revenue bonds pledge water, sewer, electric, or other enterprise funds and usually use these revenues to repay the bonds. They can only be issued after authorization from the governing body. Legal covenants typically require that revenues after operational expenses are paid equal at least 125% of the required bond payment. A governmental entity will have to increase its user fees to maintain this 125% coverage ratio.
Local governments can pledge sales, franchise, or other excise taxes for bonds sold to finance water or energy conservation projects, and they can use these same funds or other funds to repay the bonds. Sales, franchise, and excise tax bonds have been a popular financing tool because they can be used to finance nearly any type of capital improvement; they do not require voter authorization—only authorization from the governing body; and they generally receive favorable credit reviews which lower the interest rates.
Lease revenue bonds can be issued by a governmental entity and its Local Building Authority (LBA, formerly known as an MBA or Municipal Building Authority). An LBA is created for the express purpose financing, acquiring, building, owning, selling, and leasing real property and equipment. The LBA becomes the owner of the facility being financed and leases it to a governmental entity on an annual basis. The bonds are secured by the lease payments and by a first lien on the financed improvements. Because lease revenue bonds are subject to annual appropriation or annual lease payments, they do not require voter authorization, but are considered more risky and bear higher interest rates.
This tool could be used to finance equipment meant to conserve energy, but might be limited by other bonds outstanding that prohibit the use of system assets as security.
Some governmental entities may create a Community Development Area (CDA), Economic Development Area (EDA), or an Urban Renewal Area (RDA), to facilitate a water project that benefits only a specific geography, not the entire jurisdiction, and uses tax revenue generated within this area for repayment of the obligation. These areas are called increment areas. The tax revenues generated are derived from the increase in the taxable value in a project area and would generally only exist in areas that did not have water access previously. The incremental increase in taxes generated from the higher taxable value that results from new water improvements acts as the collateral, or security, for these bonds and usually acts as the source of repayment as well. These types of bonds are relatively risky because the increase in tax increment is often based on projected increases of development and valuation; hence, the full tax increment may not always be realized. Bond covenants usually require that debt-service coverage be at least 1.25 times to 2.00 times, which will dictate the amount of tax increment bonds that can be issued.
Similarly, governmental entities can create special assessment areas within their boundaries to finance water improvements or energy efficiency projects that will have a benefit to a specific group of properties; the owners of which will be required to pay special assessments that are used to repay the bonds. Governments create assessment areas by adopting an ordinance (as long as those property owners responsible for more than 50 percent of assessment do not oppose the ordinance). Once the assessment area is created and an assessment ordinance is approved, bonds can be sold. Special assessments on real property acts as security for these bonds and the repayment source. In the event of default, the properties are subject to foreclosure. Land values should exceed the bond amount by at least three times, and usually more.
|Bond Type||Security/Collateral||Payment Source|
|General Obligation||Ad valorem property tax.||Property taxes or other legal available revenue.|
|Enterprise Revenue||Water, sewer, electric, or other enterprise revenue.||Enterprise revenue.|
|Excise Tax Revenue||Sales or other excise taxes.||Excise taxes or other legally available revenue.|
|Lease Revenue||Annual lease payments and financed improvements.||Any legally available funds.|
|Tax Increment||Incremental tax revenue from growth in CDA, EDA, or URA.||Incremental tax revenue.|
|Special Assessments||Land within an assessment area.||Special assessment revenue.|
Lease purchase agreements are very similar to Lease Revenue Bonds described above, however, a bank takes the place of the Local Building Authority and accepts lease payments from a governmental entity. Unlike a LBA, the bank does not own the financed improvements, instead they take a lien position on whatever is financed enabling them to foreclose, repossess or otherwise confiscate the improvements in the event of default. Because the financed improvements are used as collateral, this financing tool is not useful for improvements buried in the ground or difficult to move. Additionally, as mentioned previously, if water or energy efficiency improvements are integral to a system and other bonds are outstanding, it would generally be prohibited to take new improvements as collateral making this tool ineffective.
This tool works well for vehicles, solar panels, detachable equipment, and in some cases land or buildings that would not interrupt the water system process were they taken in a foreclosure.